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Best Practice for Bitcoins Regulatory, Legal And BEST PRACTICE FOR BITCOINS REGULATORY, LEGAL AND FINANCIAL APPROACHES TO VIRTUAL CURRENCIES IN A HESITANT, GLOBAL ENVIRONMENT KELLY MCCONNELL SUPERVISOR: DR. EMMANUEL LARYEA Best Practice For Bitcoin Thesis – Kelly McConnell DECLARATION PAGE 2 Best Practice For Bitcoin Thesis – Kelly McConnell ABSTRACT Decentralised virtual currencies may operate outside regulatory, legal and financial systems. Despite the risks that these currencies pose to stakeholders, including consumers, merchants, and investors and to the broader economy, their popularity continues to grow rapidly. Concerns regarding volatility, security and criminality can be addressed through the incorporation of virtual currencies into broader legal landscapes on a domestic and global scale. While most countries are hesitant to take the lead on virtual currency regulation, global action is required to ensure the continued effectiveness of existing regulations and provide consumer and investor protection in this new area of virtual currencies. Bitcoin, the most widely adopted decentralised virtual currency is used as a case study in this thesis for reviewing regulation strategies in relation to virtual currencies and their associated risks. A ‘best practice’ regulatory approach is recommended for domestic and global authorities regarding Bitcoin regulation. This approach recommends Bitcoin regulation be incorporated into existing legal and financial frameworks in a way that balances the benefits that virtual currencies provide with the need to preserve a stable currency and economy. 3 Best Practice For Bitcoin Thesis – Kelly McConnell Table of Contents Declaration Page ................................................................................................................ 2 Abstract ............................................................................................................................. 3 Chapter 1 - Introduction ..................................................................................................... 6 I. Background ......................................................................................................................... 6 A. Non-Convertible VCs ................................................................................................ 6 B. Convertible VCS ......................................................................................................... 7 1. Linden Dollars .............................................................................................. 8 2. E-Gold .......................................................................................................... 8 3. Bitcoins ........................................................................................................ 8 II. Concerns with Convertible Virtual Currencies ................................................................. 9 A. Criminal Law Enforcement ....................................................................................... 9 B. Regulatory Effectiveness ........................................................................................ 10 C. Consideration of Consumer Protection .................................................................. 10 III. Concerns with Regulating Decentralised Convertible Virtual Currencies .................... 10 IV. Thesis Statement ........................................................................................................ 11 V. Organisation of Thesis ................................................................................................. 12 Chapter 2 – The Bitcoin System ........................................................................................ 14 I. Features ........................................................................................................................... 14 A. Decentralisation ..................................................................................................... 14 B. Mining .................................................................................................................... 15 C. Public-ledger ........................................................................................................... 16 II. Bitcoin Ecosystem ........................................................................................................... 17 Chapter 3 – Bitcoin: Benefits and Uses .................................................................................. 20 I. Benefits ............................................................................................................................. 20 A. Cost of Time ........................................................................................................... 20 B. Accessibility and anonymity ................................................................................... 20 II. Uses ................................................................................................................................. 21 III. Conclusion ...................................................................................................................... 23 Chapter 4 – Bitcoin: Potential Risks and Issues ..................................................................... 24 I. Economic Risks ................................................................................................................. 24 A. Short-Term Risks .................................................................................................... 24 1. Volatility .................................................................................................... 24 2. Ponzi-like ................................................................................................... 27 B. Long-Term Risks ........................................................................................ 29 II. Features .......................................................................................................................... 31 A. Anonymity .............................................................................................................. 31 B. Legal Uncertainties Caused by Decentralisation .................................................... 33 III. Security Risks .................................................................................................................. 34 IV. Conclusion ...................................................................................................................... 36 Chapter 5 – Bitcoin: Current Regulatory Approaches ............................................................ 37 I. Banning Bitcoins Approach .............................................................................................. 37 II. Wait-And-See Approach .................................................................................................. 38 A. Characteristics ........................................................................................................ 38 4 Best Practice For Bitcoin Thesis – Kelly McConnell B. Forms ...................................................................................................................... 39 III. Action Approach ............................................................................................................. 40 Chapter 6 – Bitcoin: Why Should Bitcoin be Regulated? ....................................................... 41 Chapter 7 – Bitcoin: How Should It Be Regulated - Best Practices Recommendation ........ 43 I. The Difficulties in Regulating Bitcoins .............................................................................. 43 II. General Regulations ........................................................................................................ 44 A. Actors ..................................................................................................................... 44 B. Global ..................................................................................................................... 44 C. Neutral and flexible ................................................................................................ 45 III. Specific Areas of Regulation ........................................................................................... 46 A. Public Law .............................................................................................................. 46 B. Civil Law .................................................................................................................. 49 1. Irreversibility ............................................................................................. 49 2. Consumer Protection ................................................................................. 50 C. Bitcoin as part of the financial system ................................................................... 51 1. General financial services .......................................................................... 52 2. Specific Regulations ................................................................................... 53 a. Banking Regulations ..................................................................... 53 b. Investments .................................................................................. 53 i. Investments purchased with bitcoins ............................... 53 ii. Investments in bitcoins .................................................... 54 c. Derivatives ...................................................................................
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